Hello Forex traders,
Trading with the trend is a very strong and useful concept. In my previous articles on trading with the trend a reference is made to the famous saying: “Go with the flow, ride the tide, bend with the trend” – a quote from Bill Willams. Another famous expression is:
“the trend is your friend” or “the trend is your friend until it bends.”
I think the point is clear. Take a look at the previous 2 articles to read more on trends:
However, most Forex traders also know that the trend is just part of the equation. How and where do you enter, where to you place the stop loss, where do you take profit, what are filters, how do you define the trend, etc. There are many variables that need to be answered and solved before the concept of trend actually translates into profitability.
The core point is that even though a currency pair is trending, this does not translate in immediate unconditional with the trend opportunities. In fact, the reality is far from it. Forex traders must judge whether a trend has sufficient space to develop. Not just a little bit of space, but preferably the more the better (more on that later) or in other words: Wide Open Spaces (WOS).
WIDE OPEN SPACES (IN TREND) – WOS(IT)
Te concept makes perfect sense because the trend is a great tool, but not always will the trend have sufficient space to develop. Why? Because the market environment is not ripe for trend follow through. There could be tons of reasons, for instance:
1) News events: the release of the FOMC statement which keeps traders on the sidelines until that event.
2) Price action (momentum / correction): lots of price action occurs in consolidation (70-75% is a common figure) and momentum moves are quick and profitable but occur less often.
3) Support and resistance: price is constantly battling between support and resistance (S&R). In a trend one side is winning more often, but the probability of that trend continuing is decreasing when approaching a S&R of a higher time frame.
Being able to judge how much widen open space (WOS) is available for price to move up or down is of immense importance. And it is not only important if you are trading with the trend but also for range and reversal traders. The reason why it’s so important is because with the trend traders and range traders are in search of widen open spaces, whereas reversal traders are looking for pairs that do not have WOS (to increase chances of reversal occurring).
Take a look at these articles if you want more information on these topics:
THE PROCESS OF WOS
Now that we have clarified the importance of WOS in trading in general, and Forex trading in specific, it is important to understand how the WOS method can be actually implemented in real life trading. What kind of process is needed to use the WOS concept?
In our Forex trading room we use the following steps:
1) Define the trend (see links a/b above)
2) Qualify and define the opportunity (within the trend)
3) Check for filters (that can hinder the trade)
4) Look for a trigger (which confirms our analysis in the previous steps)
5) Establish and take the entry signal (which goes through the price level of our choice)
Here is a practical example to make the theory mentioned in the points 1 to 5 livelier:
1) Trading room: looking for the with the trend continuation setups
2) Opportunity: looking for pullbacks, consolidations and chart patterns within the trend
3) Filters: news events, divergence, support and resistance, and Fibonacci levels
4) Trigger: a trend line or break of trend line
5) Entry: break of the fractal or Fibonacci retracement level
With the above process, the WET trading room is in search of Wide Open Spaces (WOS).
But that is not the end of the story… The important part of judging whether there is sufficient WOS is by comparing the reward to risk ratio (R:R ratio) of each potential setup.
That means that each and every trade setup will be judged via the R:R ratio balance. A setup which has a too low value will be filtered out. A setup which has a high enough value qualifies. What levels are considered enough? This depends on your system expectancy, which is the win percentage multiplied by average win, minus the loss percentage multiplied by average loss. But in general:
Reward to risk ratio of lower than 0.7 – too low / no trade
Reward to risk ratio of lower than 1 – WET avoids these setups / only useable in scalping
Reward to risk ratio of lower than 1.5 – possible but not ideal / depends on other factors such as remaining opportunities in the market
Reward to risk ratio of lower than 2 – decent ratio
Reward to risk ratio of lower than 3 – great ratio
Reward to risk ratio of higher than 3 – superb ratio
Forex traders can measure whether they have proper or improper reward to reward-risk ratio via:
1) Decide entry price (break or pullback level)
2) Decide technical stop loss level (using support / resistance / fractal)
3) Evaluate take profit zone at next support & resistance (1 higher time frame)
4) Subtract entry from stop loss
5) Subtract entry from take profit (TP)
6) Divide calculation of 5 by 4 —> R:R ratio
When aiming for a R:R ration of higher than, Forex traders are usually aiming the TP at a higher S&R. Purposely ignoring the closest S&R is certainly an option to increase the ration, but Forex traders do realize that due the path of least resistance dictates that the success rate of such as a TP decreases.
Sometimes it happens that an S&R divides a zone in to 2 spaces. In this case the Forex trader can employ the strategy of scaling out, and then scaling back in, thereby reducing the risk of the better TP not being hit.
With this method in hand, Forex traders will always be able to understand, recognize and calculate wide open spaces, and see if there are setups that qualify using the WOS model.
Did you ever think of this WOS concept? If yes, please tell us your experience in using it when Forex trading? If not, how do you think that would influence your trading? Are there elements you would change in your trading? If so, how? Please write down below your comments!
Wish all a wonderful weekend and Good Trading next week!
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